When he was Chancellor of the Exchequer, George Osborne made several changes to the way in which income is taxed. Personal allowances were increased significantly above the rate of inflation; a starting rate band was introduced for savings income and, with effect from 6 April 2015, this was assessed at 0%. In addition, a new personal savings allowance was introduced for the 2016/17 tax year.
In the right circumstances, chargeable gains from international investment bonds can benefit from some or all these recent developments but, in order to take full advantage, some forward planning – and professional advice – may be necessary.
For the tax year 2016/17, most taxpayers are entitled to a personal allowance of £11,000. If their income, including any non-sliced chargeable gain from an investment bond, exceeds £100,000, the entitlement to the personal allowance is reduced by £1 for every £2 of income exceeding £100,000.
In addition, all taxpayers are entitled to a starting rate band of £5,000, taxable at 0%. However, this band is available only for savings income. If non-savings income (which includes earnings, pension income – including flexible drawdown – and rental income) exceeds the personal allowance plus £5,000, no benefit can be gained from the starting rate band.
The new personal savings allowance is currently £1,000, although higher rate taxpayers have a reduced entitlement of £500 and additional rate taxpayers have no entitlement to the personal savings allowance at all. As the name suggests, this allowance is also only available for savings income.
Paradoxically, although an international investment bond does not produce income, any realised gains are taxed as savings income. Thus, potentially, chargeable gains can take full advantage of the £11,000 personal allowance, the £5,000 starting rate band and the £1,000 personal savings allowance, meaning that a gain of up to £17,000 can be triggered with no income tax liability. Note, however, that this favorable position can be fully exploited only by gains from international bonds. Gains from UK bonds have a 20% tax credit, to reflect the fact that tax has been paid within the life fund. Since this tax credit is non-refundable, full advantage could not be taken of the 0% rate even if the gain fell wholly within the £17,000.
Not many clients have non-savings income of less than £16,000, so doesn’t that mean that most would only be able to take advantage of any unused personal savings allowance when triggering gains from international bonds? The following case study illustrates just one of the many scenarios that could be of benefit.
Anna had taken out an international investment bond in March 2000. Her initial investment was £100,000 into 100 segments, and it was now worth £150,000.
She had recently retired and was taking advantage of the pension freedoms introduced by George Osborne; after taking her 25% tax-free pension commencement lump sum, she had invested the remainder of her pension pot into a flexible drawdown product. As yet, she had not taken any withdrawals from either the bond or the drawdown, but she now needed funds of around £51,000 and was considering her options.
Her adviser pointed out that, if she withdrew £51,000 from the drawdown, this would be taxed as follows:
|Tax Band||Gross Income||
|Personal allowance @ 0%||£11,000||£0|
|£32,000 @ 20%||£32,000||£6,400|
|Remainder @ 40%||£8,000||£3,200|
Since the drawdown would be regarded as non-savings income, Anna would have no benefit from either the starting rate band or the personal savings allowance.
Alternatively, Anna could take a partial withdrawal from the bond and, since this would be within the total 5% allowances, there would be no immediate income tax liability. However, the 5% allowance is tax-deferred, not tax-free. Consequently, when the bond came to an end at some time in the future, the previous partial withdrawal would then have to be taken into account and tax could be paid at that time.
Instead of taking benefits from the drawdown, Anna could fully encash 34 segments of her bond to realise £51,000, triggering a gain of £17,000. This would fully utilise her personal allowance, starting rate band and personal savings allowance, resulting in there being no income tax liability.
Furthermore, when the remaining 66 segments came to an end in the future, the £51,000 withdrawn previously would not need to be taken into account when calculating the chargeable gain. This saves £9,600 tax in 2016/17 and similar arrangements can be made if appropriate in future tax years, saving even more tax.
With a little forward planning, the gains from an international investment bond can be extracted with little or no tax being paid. Further details of how this can work to the client’s advantage can be found in our Investment Bond Briefing Note - Chargeable gains, the starting rate band and the personal savings allowance.